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For years,
Questcor Pharmaceuticals
lost money making Acthar, a drug for desperately ill babies. Then in 2007, it found a success strategy. It raised Acthar's price from $1,650 a vial to $23,000, and has been solidly profitable ever since. Its stock (ticker: QCOR), quoted below 40 cents in 2007, hit a record $16.40 in January, on hopes for added sales of Acthar to patients with multiple sclerosis or kidney disease.

But the one-drug company, whose stock-market value has soared to nearly $1 billion, will see its profits vanish this year on prescriptions covered by Medicaid managed-care programs. The villain: a provision of the big federal health-care overhaul that gives the Medicaid plans a 100% rebate on Acthar's sales price. Questcor has set aside reserves for those liabilities, but not enough, says Mark Roberts, an analyst who's spotted many an overpriced stock at his Off Wall Street Consulting Group research boutique in Cambridge, Mass. "They are way under-reserved," he contends.

Slippery Slope

Questcor hopes its promotion of Acthar for multiple sclerosis will offset Medicaid cuts.

Questcor aims to offset Medicaid's rebates by promoting Acthar as a treatment for multiple sclerosis, whose sufferers usually have commercial health insurance. Prescription sales for MS rose 66% in the December quarter from the year-earlier level. "The key question for investors," says Questcor CEO Don Bailey: "Can our scrip levels continue to grow in MS?"

THE ANSWER IS NO, ACCORDING TO Roberts and those investors who have shorted more than 10% of Questcor's free-trading shares. Growth in Acthar's MS prescriptions will slow, he argues, after some doctors and patients try the $50,000 treatment after failing with the standard treatment of methylprednisolone, which costs less than $1,000. So while bullish analysts at firms like Citadel Securities expect Questcor stock to hit 20 bucks, on 2011 earnings of better than 90 cents a share, Roberts expects earnings of 42 cents. He thinks the stock could drop to $6.50.

Questcor was floundering in 2001, when it got $1.6 million from Sigma Tau Finanziaria, an Italian drug conglomerate run by brothers Claudio and Paolo Cavazza. A few years earlier, Claudio had earned notoriety—and 1½ years of probation—for his role in a 1993 scandal in which he admitted paying kickbacks to health officials to get Sigma Tau products onto Italy's national drug formulary at increasingly higher prices. He also delivered bribes on other drug companies' behalf.

While the Cavazzas were building their control of Questcor to more than 30% of its shares, the little company acquired the rights to Acthar in 2001 from a manufacturer eager to ditch the slow-selling drug. An injectable hormone first marketed in 1952, Acthar stimulates the brain to manufacture the natural version of steroids. It's a first-line treatment for infantile spasms, a rare, terrible seizure disorder that affects about 3,000 babies a year in the U.S. For this tiny population, Questcor maintained Acthar production, but couldn't turn a profit.

So in 2007, the Union City, Calif., company adopted the strategy of outfits like
Genzyme
(GENZ), which supply drugs for rare, or "orphan," diseases at sky-high prices. A course of treatment for infantile spasms now costs about $115,000 (there have been price breaks for the uninsured). Questcor's revenue doubled in 2008, to $96 million, helping produce $36 million, or 50 cents a share, in profit.

But Uncle Sam won't pay $23,000 a vial for Acthar prescribed to Medicaid patients. In fact, Questcor must rebate 100% of the price on most Medicaid prescriptions. Because the rebate applies to such a large portion of Acthar sales, Questcor reports revenue net of a rebate accrual. Since 2008, that accrual has averaged 24% of each quarter's gross revenue, with another 4% accrued for other government discounts. Most of the Medicaid discounts are for babies with infantile spasms.

THE REBATE WILL COVER an even larger share of Acthar sales under a provision of last year's health-care legislation, which let states claim the rebate for patients enrolled in Medicaid managed-care plans. Although the discount is retroactive to March 2010, Questcor hasn't yet received claims from most of the 22 states expected to file them. The rebate accruals affect Questcor's ability to meet earnings expectations. CEO Bailey has entrusted Questcor's Medicaid estimates to his employee-daughter. "We've worked hard to get this right," he says. "But we won't know until the managed-care bills start coming through."

Mark Roberts thinks the new rebate rules might expand the covered Medicaid population by 47%. A 47% boost to Questcor's average 24% quarterly reserve would raise the accrual to 36% of sales. Yet the company set aside only 27% of gross sales in its last reported quarter, ended September.

Data on Medicaid's managed-care population are hard to come by, cautions Caroline Pearson, a senior manager at Avalere Health, a Washington consulting firm. But she estimates that 13.2 million new patients will become eligible for Medicaid drug rebates—nearly a third of the Medicaid population under age 65.

Don Bailey believes he'll handily offset increased Medicaid rebates by boosting Acthar prescriptions for MS, a market he projects could range from $500 million to $2 billion. Most of the 300,000 U.S. MS victims take maintenance medications to keep symptoms in remission. But each year about two-thirds suffer flare-ups. These are treated with methylprednisolone. Questcor doubled its sales forces last year, to urge doctors to try Acthar when methylprednisolone seems ineffective, as Bailey says it is for 40% to 50% of those with flare-ups—about 100,000 people.

The Bottom Line

Shares of Questcor, which were trading above 15 Friday, could be halved if hopes for new uses for its one drug falter and its reserves against Medicaid rebates prove to be inadequate

Using Acthar when steroids fail is an intriguing idea, says Fred Lublin, a neurology professor at New York's Mount Sinai School of Medicine, but one that requires a clinical trial. In his consulting work for the company, he's nudged Questcor to sponsor such a trial. (Lublin advises more than a dozen drug makers.)

Meanwhile, Mark Roberts says, the number of new scrips per salesperson is falling. He's also skeptical of another indication for which Questcor is touting Acthar: kidney disease. Two tiny, inconclusive studies were presented at a recent kidney-specialist gathering. Roberts says doctors tell him they'll need better evidence before ordering $200,000 Acthar treatments.

As for the Cavazzas, as Questcor stock has risen, they've cut their stake in the drug maker to about 10%.